Leonardo DRS Inc (DRS) 2006 Q3 法說會逐字稿

Good morning ladies and gentlemen and welcome to today's DRS Technologies third quarter conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded. At this time for opening remarks and introductions I will turn the call over to Ms. Patricia Williamson, Vice President of Corporate Communications and Investor Relations for DRS Technologies. Please go ahead Ms. Williamson.

Thank you, good morning and thank you for joining us on today's conference call to review DRS Technologies financial results for the fiscal year 2006 third quarter and nine month period which were reported earlier this morning. Hosting today's call are Mark Newman, Chairman, President and Chief Executive Officer of DRS Technologies, and Richard Schneider, the Company's Executive Vice President and Chief Financial Officer.

Before we begin I would like to remind everyone that we are providing a simultaneous webcast of this call to the public. An archive of this webcast will be available later today on our website. Today's remarks may include some forward-looking statements and certain non-GAAP financial metrics. For more information regarding the Company's definition of these metrics, and their usefulness in interpreting DRS's financial results, please refer to today's earnings release and our filings with the Securities and Exchange Commission. In accordance with Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, please note the risks and uncertainties related to forward-looking statements which are more fully described in the news release and in the Company's SEC filings. DRS does not undertake any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise.

I would now like to turn the call over to Mark Newman.

Thanks Pat and good morning to everyone. As our news release this morning indicated we reported a strong quarter and continued the positive momentum of our first half. Revenues were higher than last year's third quarter by 15%, organic revenue was about 6% and the balance was generated by acquisitions. Third quarter operating income was higher by 14% and represented an 11.5% operating margin for the period. EBITDA was strong at 14.1% of sales and was 14% above EBITDA from continuing operations for last year's third quarter. 17% higher net earnings for the quarter resulted in $0.69 per diluted share on average shares outstanding, on higher average shares outstanding, than the same quarter last year. We ended the quarter with funded backlog of $1.64 billion, 25% above backlog at the end of fiscal 2005.

In addition to our strong financial performance we accomplished some important achievements during the quarter. Our C4I Group shipped the first turbine generator set to the Marriott Marine Shipyard in Wisconsin to be installed on the first Littoral Combat Ship. As most of you know, the LCS is a new family of mission focused ships. A relatively large number of LCS ships are being planned with anywhere from 56 to 60 currently anticipated to support a wide range of joint missions. They will be equipped to face threats from surface craft, submarines and mines. With demand for the FBCB2 tactical computers rising, our Tactical Systems business took steps to increase their production rate to satisfy the Army's immediate fielding requirements. The FBCB2 computer systems are being installed on Abrams main battle tanks and Bradley fighting vehicles to support the Army's Blue Force Tracking requirements as part of the military's objective to improve battlefield situational awareness. FBCB2 continues to be a strong program for DRS and we expect to see steady growth in new orders in the months ahead.

During the third quarter, our Surveillance & Reconnaissance Group successfully completed the first flight test of the advanced rangeless P5 air Combat Training System Pod. This pod is easily mounted on to fire aircraft for in flight training. The P5 Combat Training System is an indefinite delivery/indefinite quantity ten-year contract supporting the Air Force and the system is designed to replace existing training instrumentation on U.S. Air Force, Navy, Marine Corps and Air National Guard fighter aircraft at more than 25 sites including aircraft carrier facilities.

The cost-effective targeting system was successfully demonstrated by our S&R group during the quarter as part of the Army's advanced concept technology demonstration which supports network centers for the Future Force. The ultimate objective of the [set's] effort is to provide a fully integrated censor suite automated for application on unmanned ground vehicles which will support the Army's future combat system initiative.

We also successfully demonstrated a prototype of a new low-cost integrated Dewar Cooler assembly. The high-performance and lower cost of this Cooler used in advanced infrared technology application should ultimately allow us to penetrate new markets with more competitively priced cooled infrared products.

Taking a look at the nine-month period, our results were strong with increases across the board. The 15% increase in revenues included 6.8% organic growth. The 17% increase in operating income resulted in a 10.9% margin for the period and net earnings were up 26%. Free cash flow for the nine months was $33 million and we expect to generate $40 to $50 million in free cash flow for fiscal 2006. Bookings for the nine months were very strong at $1.4 billion and our book-to-bill ratio was 1.3 to 1 for the nine-month period. As you know, on January 31, we completed the acquisition of Engineered Support Systems which is now DRS's third operating segment called the Sustainment Systems and Services Group. The new S3 Group is led by Dan Rodrigues who is named Group President. Dan is the former President and Chief Operating Officer of Engineered Support. For those new employees who may be listening on the call today I would like to extend a warm welcome to you. We are very excited about our new company and the opportunities that lie ahead of us. We're looking forward to working with all of you to offer our customers the expanded product and services capabilities that the combined company can now offer.

The addition of Engineered Support Systems is an important milestone in DRS's growth contributing a significant base of systems, products and services focused on military force sustainment, technical and logistic support, integrated military electronics and field support equipment. The combination of the two companies firmly establishes DRS Technologies as a leading total solutions provider of defense products and services, about 10,000 employees strong and a leading mid-tiered defense technology company in the industry with $2.9 billion in revenues expected in fiscal 2007.

Our expanded capabilities now position DRS as a major supplier in Armed Forces modernization, personnel mobility and operations and maintenance support while providing new opportunities for growth and intelligence and homeland securities markets. We are looking forward to integrating this new operation with DRS and intent to fully leverage the strength that this combination provides. Simultaneously with the completion of the acquisition the company was named to the S&P Mid-Cap 400 Index, another milestone in our growth.

As you saw in our earnings release this morning, we updated our guidance for fiscal 2006 to reflect the acquisition. Our adjusted estimate for full year revenues of $1.69 to $1.71 billion or about 30% above last year sales included the addition of two months of expected revenues from the acquisition which we estimate will be about $170 to $180 million. Our operating margin is expected to exceed 11% and we anticipate diluted EPS of $2.55 to $2.60 on 31 million diluted shares outstanding. This is about 23% above diluted EPS last fiscal year on 12% higher diluted shares outstanding.

Beginning in the fourth quarter, our guidance includes significantly higher weighted average shares outstanding of approximately 37 million, 32% higher than the 28 million shares outstanding for last year's fourth quarter. Fourth quarter guidance also includes the impact of an estimated $5 million in financing charges associated with the Engineered Support transaction. The results for the nine months coupled with our outlook for the fourth quarter support our expectations for a record fiscal 2006 when we close the year on March 31.

Before I turn the call over to questions let me just add that while the President's budget request still needs to be approved by Congress, it supports several of the initiatives DRS is involved in and makes clear that defense remains a national priority. We believe DRS is well-positioned to thrive in the current budget climate and is strategically vested in supporting initiatives for modernization, recapitalization and transformation.

I now like to open the call for questions.

Thank you, the question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) Gary Liebowitz of Wachovia Securities.

Thanks, good morning. It looked like your margins in C4I picked up a little bit in the third quarter relative to the first half. Is that just a function of mix or is there any onetime favorable adjustments in there?

No favorable adjustments, Gary, its mix and there was an unfavorable adjustment in the first half of the year.

Okay, also Mark, you are saying that Engineered Support is going to be reporting as a stand-alone business, but are you looking into integrating some of the hardware elements of Engineered Support into your existing structure?

There are a lot of opportunities for us to work together with the people at Engineered Support, but we felt in laying out the business for the future the best thing was to set them up as a separate group and then try to see where we can work together. Because the first step is always where can the managements of the different divisions that we have work together to go out and win new programs. So there are a lot of plans for the future, most of them rest though on really just the success of the business combination. There are so many opportunities to be working together to get more business I can't begin to tell you.

Okay, and one more for Rich, it looks like the sales contributions from the recent acquisitions stepped up a little bit in the third quarter. Are they tracking ahead of plan and does it look like you will have to be paying the earnouts on Codem and WalkAbout.

They are on plan, slightly better than plan and yes, we hope we do have to pay the earnouts there.

Okay, thank you very much.

Steve Binder of Bear Stearns.

I just wanted to, Mark you may have just touched on how much supplemental funding was included in the bookings in Q3, I think it was $300 million year-to-date previously?

It really wasn't that much in Q3, we try to take a look at it, you are probably looking at $10 to $15 million, it was pretty small.

And is your expectations in the fourth quarter will be relatively modest again, something like $30, $35 million or --?

We don't expect tons from the supplemental; we expect to see good bookings for the fourth quarter. As you know, we pulled a lot of bookings that we expected in the third quarter into the second quarter. So bookings have been very strong and it is always good to bring them in early.

There's a lot of talk that the supplemental for fiscal year '06 for the procurement slice of the budget will be substantially more than '05. Granted we haven't seen any good data on the second tranche, I am just wondering do you think that you're likely get more bookings in the upcoming year out of the supplemental than in fiscal year '06?

You never know how those are going to come out but we expect to see a very healthy bookings year next year from all indications.

As far as organic growth, is organic growth, traditionally third quarter has been all over the place as far as organically and I don't believe to make too much of a deal about any given quarter. But is it tougher -- do you have pretty good visibility is this going to be a low point for organic growth? Should it start improving from here out over the next four or five quarters?

There is no question we are going to see improvements in organic growth. Really the real improvements are in the bookings in organic growth because the organic bookings are enormous. So I think what you are just seeing as we have got so much in backlog and some of these are new programs so as we are beginning to dribble out the initial production of some of these, it's a little slower than we would have liked to have seen in the third quarter but we are seeing that picking up starting in the fourth quarter and certainly in the first quarter of next year. So I think you are right; I think you'll start to see an increase in organic growth.

Is your expectation for the book-to-bill to get back to 1 or above 1 in the fourth quarter?

Yes, we're always looking to see that we book at least what we ship. And as you know some of the bookings that just tie to one or two programs that could flip into one quarter or the other and really have no impact on our sales. But it's just from a booking standpoint when do they come in? So if you've got a $50 million booking and it comes in March 31st, then you've got -- you could have a higher book-to-bill and if it comes in April 1st, it switches into next year. All I can say right now is we are looking at very healthy bookings going forward and I think we should finish the year pretty strong.

When you announced the ESSI deal you talked about pro forma revenues, the Army would be about 42% of your business for '06. If you look out to '07, can you see a step function up? Are we going to be moving closer to 50% do you think?

Our first indications probably were around 45%, but we will just have to see how it comes out. As you know, the big thing is going to be the step up in Air Force for us which should probably get to about 25% of our business.

Right, Rich, just a couple quickies. Cash taxes in the quarter?

Cash taxes paid in the quarter were just under $15 million.

And then working capital, can you maybe talk about the puts and takes?

A lot of moving pieces, in total, working capital increased $8.2 million. Receivables were favorable by $18 million. Inventories were unfavorable by $20 [million], somewhat offset by increase in payables of about $19 [million]. Prepayments were unfavorable by $5.3 million, advances were unfavorable by about $12 million and the balance offset it comes to the total increase in working capital of about $8.2 [million].

Okay, and then just margins and Codem and WalkAbout and do you see -- how strong were they in the quarter or did you -- will you be identifying that in the Q (10-Q)?

That will be in the Q and the Q will be filed later today.

Okay, fine. Thanks very much.

David Gremmels of Thomas Weisel Partners.

The talk now is another $70 billion of supplemental funding coming up. And obviously last year DRS was a big beneficiary of last year's supplemental with your infrared systems and FBCB2 and others. Would you say, I realize it's a little early to be talking about this but would you anticipate similar participation in this supplemental?

I think if you had to anticipate I would say yes, but we did not anticipate it last year either, it is just a question of how it comes in and when they decide to buy stuff. But we think it is going to be a strong year next year.

Okay, and the midpoint of your Q4 revenue guidance range it probably is about 15% organic growth, obviously a major acceleration. You mentioned some of the programs transitioning to production a little bit slower than expected; can you tell us what those programs are? Are there any major issues there? Do you have enough visibility to have confidence in that acceleration in the March quarter?

Yes, it is primarily tied to our Apache program and the TWS program. And both those programs are looking very good right now. They got their arms around the problems and the stuff is starting to go out the door, so we're feeling pretty good about it.

And for these programs that are moving into production in '07, is that -- does that have some potential to bring some lift in margin as they exit the development stages?

They have our normal margins, you'll see, actually it will help us on a cash flow standpoint because expenses on these programs due to the delays are a little front-end loaded. So you will see an improvement in the working capital and the free cash flow generation but the margins are pretty consistent.

Okay and I wanted to clarify the Engineered Support contribution in the March quarter. When you announced the deal you talked about around 280 million of revenue from ESSI and now you are saying 170 to 180 even though I think the transaction closed a little earlier than expected. What is happening there?

No. You actually have it backwards, when we originally talked about Engineered Support in the September call, we anticipated it to close before December 31st. Now it actually closed January 31st so we lost over a month. That is why it is lower. You just have it reversed, that's all.

And you didn't specifically address the '07 plan, but are you still anticipating like $2.9 billion top-line and little over $3.00 EPS?

Yes, nothing has changed from what we have said before.

And is that EPS number that you talked about previously does that include FAS 123 options expense?

Yes it does.

And how much?

About $0.10 a share.

Great, thanks very much.

Ferat Ongoren of Citigroup.

Good morning. One quick question on the Engineered Support side. The DPGDS contract, I guess it was back on track in December. What's the progress so far? Are you seeing any problems? And if not, is there a chance for potential upside in 2007?

Well, I think DPGDS is back on track. And usually when programs get back on track, you start to see upside because they start going out the door faster. I think it is a little early for us to really comment on the program. I have visited with the people that make the product, and was pretty impressed with the product in general. And I think there is a nice future for that product, and the military seems to want it. So I think that it should be in good shape.

Okay, great. In terms of the Surveillance & Reconnaissance margins, there was a sequential decrease. Is that due to some of these programs you mentioned, and if that is the case, should we again assume a better margin going forward?

Yes, I think that -- what happened with some of these programs that I mentioned was really you didn't have like an engineering development program prior to production, and then you didn't have like an advanced production, a preproduction run. What has happened with those programs is they need the stuff so quickly that they kind of -- I don't mean us but the military skipped over that piece of the program. So anytime you are trying to go from design straight to production, you always going to have a hiccup and that is why we saw a delay and some additional costs being spent. But both those programs are in really good shape right now.

Okay, great. And now on the shipbuilding side, it seems like DD(X) is well funded; what is your view there? Could we see some upside to your engine program there or do you see any other upcoming contracts like displays, etc.?

We have got a lot of initiatives as you know going on DD(X), and we hope to see that as a nice part of our business. We're working it; keep in mind that it is nicely funded in the budget request for this year, the budget that got signed. But programs like that are an uphill battle every year until they really get into full production. I think for now, we are seeing opportunity, and we're working that opportunity, but it is hard at this point try to quantify exactly what that is going to mean.

Thanks very much.

Howard Rubel of Jefferies.

Thank you very much, a couple of things, good morning. First if you could give us what the January 31 balance sheet ended up looking like? I know that with the transaction that might be helpful?

It is way too early, Howard. We closed nine days ago and it will take us a while to go through with an appraiser to determine the value of the intangibles, the goodwill, things like that.

How about total debt and I'm sure you have at least a few million in cash going rattling around in the till?

The debt, if you look at all of the documents we filed it went exactly in line with the debt. I can take you through it, but I think it's much easier for you just to look at the documents.

Sure, no, I wanted to make sure that it did come in line with that. And then it looked to me like your cost of money was just a shade better than your assumptions, is that a fair conclusion?

Right now, if the remaining assumptions hold online we feel pretty good with the financing. If you have an opinion as to where LIBOR will be for the balance of fiscal '07, I'd love to hear it, but we feel pretty good.

I won't share that with you online, I will tell you that. Just a couple other things, as you -- were you impacted a little bit by the delay in the Appropriations Bill? There are clearly some short cycle products in your productline market?

I would say very little. We were very fortunate that we this particular year, we booked a lot of stuff in the first half. And then, of course, we went into the year with a strong backlog so that really didn't hurt us. Because remember, even after they signed the Bill it always takes X number of months before you actually see contracts; it's not like they sign the bill and you get a contract the next day. Everything we were working on is in the works. So I think that there is no question one or two things slipped from the third quarter into the fourth quarter but we had many more things slipping from -- moving up from the third quarter into the second quarter. So all totaled I think we have got a very strong backlog and we are in good shape not just for the remainder of this year but also going into '07.

Two more things and then -- one is if we look at the run rate though for ESSI for these two months, it looks like it's a little bit lower than what you would be targeting for all of '07. Is this some seasonality in here or some other items that really explain that?

Keep in mind that what we talked about for them for next year was about $1.2 billion, and we don't see anything that has changed on that. And that would put them at $100 million a month and you have -- there may be a give or take in any particular month. We also haven't finished March, so you don't know precisely how they are going to end up until they actually end up that way, so we will have to see. But I think that from everything we have seen so far and what we have forecasted they are right on target with where they should be. Remember, they just came off of a billion dollar year, and we're projecting a $1.2 billion year and they have got to move over to our accounting system. And also our fiscal year, so it's going to take us a couple of months to actually figure out precisely where they are on a quarter-to-quarter basis. But I am not concerned about anything right now.

And then the final one is also a small item; I mean that was big but the smaller one is. Other income was also relatively strong in the quarter, Rich, is there anything there other than interest income?

No, it's just interest income.

Thank you, gentlemen, very much.

Patrick McCarthy of Friedman, Billings, Ramsey.

Good morning, this is Greg Agnew in for Patrick. Just a couple of quick questions, first from a housekeeping perspective. With respect to your convert, it looks like from your filings that that settles in cash so we should assume that that will not be impactful in the FY '07 diluted share count, right?

That's correct.

Okay, and just for FY '07 shares, is sort of about 41 the right number to be using?

Yes, I am using a little less in my model, you are in the ballpark.

Okay, and then I was wondering if you could break down organic growth by segment, C4I and Surveillance & Reconnaissance?

Yes. For the quarter, C4I was zero, they were slightly down and S&R was up 14%. On a year-to-date basis, C4I is at 8.1%, and S&R is 5.3%. You can see by quarter it is very volatile.

Yes, great. Just a follow-up on one of the previous questions, it looks like the Navy shipbuilding plan is far more robust than it was at this time last year. I'm just wondering if you could address how you see that impacting your business that addresses that going forward?

I think it's going to have a positive impact on us; there is no question about that, but we always knew the Navy was going to keep building ships so there is no big mystery in what happened. The CNO (Chief Naval Officer) has talked about very robust ship building future. His big concern is he wants to get the cost of these ships lower. And a lot of what we have to offer can help them do that, so we are feeling very positive that we are going to play a role on both of these new platforms, DD(X) and LCS. And we just have to take it a contract at a time.

Okay, great. Thanks. Nice quarter.

Alok Chopra of Oppenheimer Capital.

Quick question regarding the guidance, I don't know if you addressed this already, I'm sorry. For the fourth quarter, $0.72 to $0.75 including the $5 million charge which I guess is about $0.08, so consensus is around I think $0.80 for the fourth quarter. And I presume nobody had this in the consensus, so was this disclosed before, was this charge disclosed before?

I think there is a lot of confusion, some of the analysts were taking into account the impact of the acquisition and the higher share count, some weren't. The earnings projection is up significantly but you've got to remember we are now in the where we had about 28.5 million shares outstanding in Q3 and a lot of analysts were using that in their projections for Q4, we're now talking about 37 million average shares outstanding for the fourth quarter. This is going to be one of those years where you can't add up four quarters and come to the EPS for the year. The share count for the quarter is going to be 37 million; the share count for the year is going to be about 31 million.

Yes, I understand the share count is moving up, but I don't believe this charge was factored into people's estimates or maybe it was. But it would be helpful to get a little more clarity on these things because if you look at where your stock opened this morning, I think people were somewhat confused about whether you were lowering guidance for Q4 or not. And to me it looks like you are not, so that is why I was asking the question. But otherwise, anyway that is all I had. Nice quarter. Congratulations.

No, you are absolutely right; we weren't lowering guidance at all, and it actually improves -- it actually implies a very improved operating result. So I mean this was tremendous, actually. I think you hit it right on the head.

Okay, great, thank you very much. Good luck with the integration of ESSI.

Thanks a lot.

(OPERATOR INSTRUCTIONS) Greg Alexopoulos of Morgan Stanley.

Good morning, gentlemen. Nice quarter. I just want to talk a little bit more about the guidance, you have raised top-line guidance because of ESSI but you have maintained your EPS guidance as far as I can tell. Can you give us some more indication of the offsets to kind of maintain your bottom-line guidance?

What we have done is the earnings have increased significantly. There are more shares outstanding than the previous guidance that we put out. Remember, the average share count was about 28 million for the year, or 28.5, now we are at 31. And again with the closing of the transaction there are certain charges that will hit in the fourth quarter of about $5 million that have to be absorbed that are now being absorbed in the guidance.

On the topline guidance it looks like if you take away the ESSI contribution of $0.17 to $0.18 for the fourth quarter, if you look at the annual guidance it looks like you just basically bumped up the lower end of the guidance by a few pennies, is that right?

No, we have also increased the high-end a little bit but again you have got the $5 million charge.

Right, but I am strictly talking about the top-line guidance.

You're talking about the revenues?

Yes.

We have bumped up the low end a little bit and the high end a little bit.

Okay, can you give us a sense on the percentage of development to production in each of the two quarters and overall as well?

When you say each of the two quarters?

I'm sorry, each of the two divisions.

You mean between C4I and S&R?

Exactly.

I couldn't do that off the top of my head, I'm sorry.

Okay, and kind of based on what I have got, fourth quarter looking at very strong results for 19% sales growth and roughly 12% plus margins, is there anything that would change those prospects?

No, you are looking at incredible results; you're looking at the fact that we absorbed $5 million of charges without missing a beat. You're looking at more shares outstanding and on top of that, if anyone did a detailed calculation they would find that by the time the deal closed and we averaged the shares outstanding for the ten days prior to closing we used a few more shares then we would have otherwise used. Because when we first announced the deal we were talking around $52 a share and then because of various arbitrage and short selling and this kind of stuff, the average came down in the high 40s. So we ended up issuing hundreds of thousands of shares more. So overall, I think what we have done is we have absorbed all the shares, we have absorbed all the special charges, $5 million. And the guidance is in tremendous shape, so if you take a look at it you see way improved operating results. And I think that is the way to focus on this thing.

Right, and on -- since you have integrated ESSI or since it has closed, Mark, how do you think that is going to alter your capital distribution strategy going forward? I assume we should expect to see fewer acquisitions as you try to pay down debt?

Yes, we said that on all the road shows, we said that we were going to slow the whole process, the acquisition process down certainly for 12 to 18 months and concentrate on paying down debt. That is exactly what we're going to do.

And finally, now that you have had roughly six months dealing with ESSI and basically a week since it's closed, could you give us some more color on any positive or negative surprises that you've seen in that business that you weren't aware of prior to discussions with them?

Actually, it is one of the few cases where I have been getting more excited about a company we've bought than less after you buy it. Because usually you buy a company and then you become a citizen of the company and you get depressed, but in this case, it's actually been very, very positive. For example, they do the perimeter security and all of the access control for the Pentagon. And I would say how great it is going to be when we start putting DRS logos on all of those entrances and exits to the Pentagon. Everyone walking in there is going to see DRS. And there are a number of other initiatives that they have got going that I think are going to bode well for the future. Especially in the services and security, homeland security areas. So we are very bullish on where this can go. The other thing and you hit it right on the head, even though we just closed January 31st, we have been talking with these people since the deal was announced, and our guys are working together on tons of initiatives where they think we can bring a lot more value to the customers. So we are seeing a very, very positive interaction between all of the people at Engineered Support and the people at DRS right now. So I think it is going to be very, very positive going forward.

Great, thank you very much.

Steve Levenson of Ryan Beck.

Good morning Mark and Richard. In particular related to homeland security there is apparently a big initiative to install high-grade thermal optics along U.S. borders. Do you think there is a place for DRS to participate there?

Absolutely and we're working on a number of initiatives right now.

Any idea of the size of the market? It looks like government is going to be spending a lot granted, not all of it is going towards what you all make.

I learned a long time ago that I don't get excited about size of markets in this business because it all comes down to what contracts you win. So even though my marketing guys always give me a lot of fluff I wait to see a contract in hand, then I talk about where that contract can go to. But you've got to get the contract. One of the things we have talked about before the only time we ever competed against Engineered Support was for a radar system that was going to be used in border control. And border patrol rather. And they ended up winning the program, so now we are on that program and I think once you --.

That is one way to win it.

That is right. And once you have got a toehold then we have got a lot of other products to offer both from the point of view of computers, sensors, and radars and we are going to begin to integrate all of that stuff. Sometimes selling directly to agencies and sometimes hopefully working with the major clients as part of their systems that they are going after.

And can you give us an update on where DRS is these days on unmanned vehicles? Whether it is airborne or surface or subsurface?

Well, we are about to book a good contract; we have been waiting for this and one of the reasons the bookings were a little lower, most of it was because we booked stuff in advance. But there was one program that was supposed to come in last quarter which looks like its coming in this quarter. So I think our unmanned -- although its not going to be a giant company is going to be a pretty decent company. We are seeing a lot of interest in the vehicles that we are making.

Okay, thanks very much.

Michael French of Kaufman Brothers.

Good morning gentlemen. Congratulations on a strong quarter and closing the ESSI acquisition.

Thank you.

I realize this might be a little premature given its been a short time since you closed ESSI but how would you characterize your appetite and financial flexibility to do another acquisition, say this calendar year?

I wouldn't categorize it as very high. Right now what we're trying to do except for an occasional bolt-on acquisition is we are concentrating on paying down debt. That is what we told everyone and we're going to be generating a lot of cash and we are going to take that cash and use it to pay down debt, that is our goal.

Okay, that makes sense. Thank you.

Peter Arment of JSA Research.

Good morning, Mark and Rich. You really just hit upon one of the questions I wanted to ask which was regarding homeland security. You have done a very nice job of raising your Air Force exposure and your Army mix is certainly impressive. You gave us some pro forma numbers previously, I think it was less than 10%, but could you just remind us what you think your overall exposure is to the homeland security market is or budget?

We had said about $50 million, that we're looking at right now if you combine work we're doing with the Coast Guard and then some of the other work in perimeter security and communications. So I think that that is a good starting point and then we're getting our arms around -- because we had initiatives going, both at C4I and Surveillance & Reconnaissance, and now we have a lot of initiatives at what we're calling S3, the new group. And we're putting our heads together so that we can have one face to the customer with a myriad of products and services. And so I think as you see spending on homeland security grow you're going to see us get bigger pieces.

Okay and that is $50 million with pro forma with ESSI?

That's correct.

Okay, great. Thanks guys.

Mitch Nording of Opus Investment.

Good morning, very nice quarter. A couple of questions, one would be on the DPGDS, can you talk about what kind of run rate operating margins you're looking at on that program?

I think that is a little early for us right now.

But you see them returning to the margins that they had at a minimum margins they had late last year, or Q3 last year?

Yes, they had -- it was a very good program and the biggest problem they had in the program was actually associated with the engine that they were purchasing and using in this system. And they have been working very closely with the engine manufacturer and they believe that that problem was licked, so there is no reason why they can't continue with decent margins going forward. And the advantage always when you buy a company is that sometimes some of that baggage gets left behind and then you are starting fresh. But for us sitting in this room right now talking to you it is still a little early on. We have not had an opportunity to do operating reviews; we have had teams working with them to get the closing done, and to begin setting them up for reporting in the fashion that we report. And it won't be until the end of next week actually that we are going to have our first operational review which we have quarterly reviews where we sit down with the team of the individual groups that we run, and then go through the programs. And this will obviously be one of the programs that will come up. So we will have -- by the time we get on the next call we will know a lot more about all of their programs from the way that you are interested.

Also, can you talk a little bit about the integration, I know in terms of signage, how quickly there will be a name change; will there be a name change to a lot of their product line?

Yes, there is a name change to everything. In some cases, we have kept names and put DRS in front of them. And in some cases we have come up with new names and all of them -- they started -- guys are walking around with DRS cards now. You go to a number of their buildings there are DRS signs. In some cases we just roll down a cloth sign; in another cases we've started to put up signs, but it is proceeding on schedule and before you know it every place you go you will see the DRS logo.

Great, and lastly just talking about what might be considered I don't know a contingent liability on the Wells notice side, can you address where that stands and does that affect you at all? Or is that just strictly individuals that were working at the company?

Right now, I have no more information than you actually have from all the documents that we have put out. There is no new information in my head.

Okay, and also on the foreign contract side, they seem to handle that differently than you guys obviously that was a pretty small part of their business. Can you talk about how that will go in terms of integrating?

We have an incredible export control department based in our Washington office and everything they do will be tied to what we do. So they will be a first-rate company when it comes to export control.

Terrific, thanks very much.

David Gremmels with a follow-up, Thomas Weisel Partners.

Thanks, just a quick one, maybe a different way of looking at the Q4 issue, your previous guidance was $2.55 to $2.60, your current guidance is $2.55 to $2.60. So on the $5 million charge it didn't look like there was anything that would not have been expected, so was that charge in the previous guidance or was it not?

No, that charge was not in the previous guidance.

The previous guidance was without the acquisition.

Remember that because when we put out the last guidance there was no acquisition in there. So that $5 million was not in the guidance. And the shares were not in the guidance. And what we said if you recall, when we first announced this deal, we said we would get -- we were expecting at that time over a quarter's worth of sales, and we expected a zero change in our guidance for the year. In other words all the profits they were going to make was going to be offset by the normal interest and stuff that we were paying because you have a short period. It was going to be a one quarter period, so basically and nobody was anticipating that $5 million, so basically what you have now is two months and we absorbed $5 million. So you're absolutely right, this is much better than we gave last time by $5 million.

Okay, that is crystal clear. Just another quick one I think you mentioned this but I didn't catch it, what DRS stock price was used to calculate the equity component of the ESSI purchase price?

The final number came in at $49.08. That was the average price.

Great, thanks very much.

(OPERATOR INSTRUCTIONS) Richard O'Reilly of Standard & Poor's.

The $5 million I wanted to make sure that was a onetime. Can you give us the run rate for interest expense for the ongoing, either for the fourth quarter or as an ongoing rate now?

The assumption that we have in our model is about $124 million for the year. For fiscal '07.

All right. Okay, okay. And the tax rate for the new year, is it still I think you used 41 before?

Yes, we're still analyzing that, but that should be ballpark.

Okay, fine, any other numbers that you can update with ongoing?

As I said, your share count, the average shares outstanding should be between 40 and 41 million.

Okay, okay, good, thank you.

Greg Alexopoulos, Morgan Stanley.

Thank you. Mark, you talked about homeland security a while ago that it is going to be I want to say $50, $50 million -- I don't know if I heard that correctly.

Yes you did.

Have you seen a substantial uptick in homeland security because I believe some of your competitors reported last week and they at least one of them mentioned that they have seen a substantial uptick. And I was sort of a positive surprise for them?

What we are seeing is yes, we are. We are seeing a more positive outlook. As the various constituents that are involved in homeland security are figuring out how to spend money now. It still not going to be as quick as people predicted a couple of years ago, but there is no question that this is going to be a big part of the future of spending in America, is protecting the homeland. And what they are trying to do is to figure out what piece goes to state and local government, what piece is going to go to individual installations, and which piece is going to be tied to the military. So what we are starting to look at is homeland security and homeland defense. Which are two terms that we are playing with and they're not necessarily interchangeable. So I think what you are seeing is definitely some activity that we didn't see before. But it is still going to be slow, I don't think you're going to see a big push overnight. But I think you're going to see trends that are starting to pick up.

What type of profitability do you see in that area?

It is too early to talk about that. I mean, you know, there is no reason why it shouldn't be profitable. It is going to depend on the types of products that are sold. If it is a homeland defense type thing that is sold in a military format then you're going to see the typical 10 - 15% military kind of profit. If it starts to become commercial item that is sold through distributors and things like that, you may see different kinds of markups because you will have a few people handling it. So it's really going to be a function of who buys the equipment and what their mechanism will be. And whether you are talking about individual products or you're talking about systems.

Right, and one final one. On the supplemental they're talking about the additional $70 billion that they are going to propose to Congress which would total roughly $120 billion for I guess they're going to put in FY '06. Do you have any sense of how much of that is going to go to the weapons account versus O&M?

Not sitting here right now, but I think you're going to see it in both areas. This is a lot of spending. When you add up the President's budget, plus Iraq and Afghanistan, in the supplementals and a bunch of other things you're probably talking $600 billion is being spent, total. So when you add in homeland security as well, that is a lot of money, and hopefully the government spends it smartly.

And there appear to be no further questions at this time. Gentlemen, I will turn it back to you for any closing or additional comments.

I just want to thank you for joining us on the call. I am glad we had the opportunity to clarify some of the issues with the fourth quarter because we really are showing a very, very positive fourth quarter. And I also think if you didn't catch it in Rich's remarks, the fact that we're going to be absorbing all of the FAS 123R expense next year and still turning in a good year I think speaks a lot for the progress that the company is making. So all I can say is thanks for joining us and I look forward to speaking with you again on the next call in May. Thank you.

That will conclude today's conference. We thank everyone for your participation.